Tuesday, August 19, 2008

What's the number for 911?

In yesterday's WSJ, Ethan Penner ("a pioneer in real estate finance" according to the Journal (wouldn't that make him well over 100 years old??)) says the following:

To understand exactly what is happening, one needs to properly understand what occurred in the late stages of the prior cycle. Interest rates had been driven to historical lows in the U.S. and throughout the world. The cause of this can be debated. However, it is clear that economic globalization, with the migration of jobs to low-wage nations, had a profound impact on inflation, and thus on interest rates.

Ignoring the issue of how globalization affects inflation, Penner is (here and throughout the article) making the basic error of confusing real and nominal returns:

The flip side of a low-interest rate environment is that it reduces the absolute level of returns that are available to investors. This has significant implications for the massive wave of baby boomers, which holds many billions of dollars in retirement savings, either through direct investment or through managed pension-fund systems.

People, repeat after me: A 10% rate with 15% inflation is not high and a 5% rate with 0% inflation is not low.

If you read the full article, Penner also seems to believe that the shape of the yield curve is time invariant!